The desire of South Korean bond fund managers is set to ensure that money keeps pouring into 10-year government bonds in the country, and could lead yields in the debt to tighten by another 50 basis points (bp) from 3% by early next year.
The bonds have already proven to be a draw to a number of local investors, who began expanding their holdings in the bonds months before the Bank of Korea’s surprise 25-basis point cut in July. The cut triggered yields to tumble 50bp to a record low 3%.
Oh Joon Hyeon, head of the fixed-income division at Daewoo Securities, is one such investor. He believes that rising demand for the debt from local and overseas investors is likely to push the 10-year bond yield down further into the mid-2% range by the first quarter of next year.
“It’s hard to find paper that has a stable outlook and pays returns at a range of 3% these days,” Oh told Asiamoney PLUS. “We’re really sensitive to the ensuing credit crises, so we are mainly focusing on bonds of the highest credit quality. In the current low interest-rate environment, Korea fits the bill.”
South Korea’s 10-year government bond is trading at 3.03%, while Japan’s 10-year trades at 0.027%. The US 10-year Treasuries trade at 1.65%, while Germany’s 10-year bond yield recorded 0.385%.
Oh and many of his peers are betting that the 10-year benchmark bonds will continue to outperform or hold their value as the global economy continues to show unconvincing signs of a recovery. The Korean central bank is widely expected to cut its benchmark rate once more before Christmas.
Daewoo Securities, which holds KRW13 trillion (US$11 billion) worth of domestic and foreign bonds, began increasing its holdings of the country’s 10-year debt in April, an investment that helped it triple its revenue in July. The brokerage says it intends to expand its investments in the asset class as it seeks yield among bonds that are rated above ‘AA.’
Foreign investor holdings of Korean debt reached a record KRW 89.6 trillion in July, according to data from the Financial Supervisory Service. The surge was driven mainly from purchases by central banks in Norway, France and China.
At the same time overseas funds sold KRW700 billion in stock during that month. Stock trading volumes in June fell to KRW7.4 billion, the lowest level this year, according to data from Korea Stock Exchange.
“Domestic insurers and pension funds are also switching into this asset so we’re seeing a shortage of supply. Even the world’s most conservative central banks have become positive on Korea’s 10-year and have started buying them, so everyone’s just running for it,” said Oh.
The Bank of Korea left its benchmark repurchase rate unchanged on August 8 at 3% and warned that a momentum in recovery was “slackening.” Exports, which account for half of the country’s growth, dropped more than expected to 8.8% in July, marking the fifth decrease this year.
“Korea’s economy is also exposed to its own set of problems, but I don’t see that posing a systemic risk to the overall economy,” said Oh. “It’s nothing like Europe and the government is doing a good job in making sure that doesn’t happen.”
Slowing growth is prompting Woori Investment & Securities to take a more conservative trading strategy by buying more long-term government bonds.
“The global economic outlook doesn’t look that good,” said Nam Jae Yong, head of the fixed-income department at Woori Investment & Securities, which also purchased five and 10-year bonds in the second quarter. “So we’re sticking to the longer paper because Spain and Europe will continue to affect Korea and this is where we feel comfortable that we’ll be able to make our margins for customers.”
South Korean corporate bonds have also seen huge demand drive up prices, with the country’s largest banks trading at an average 10bp spread from government debt with similar maturities, Woori’s Nam said.
But the fact that Korea’s government bonds are more liquid will keep him more focused on buying public debt.
“Corporate credit yields have also fallen a lot but we’re not convinced that these bonds will able to withstand more negative news that we might see from Italy and Spain,” he said. “Now is the time to be more cautious.”